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Document 81 of 113.

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JUNE 22, 1999, TUESDAY

SECTION: IN THE NEWS

LENGTH: 4204 words

HEADLINE: PREPARED STATEMENT OF
DENISE STRAIN
GENERAL TAX COUNSEL
CITICORP, CITIGROUP
BEFORE THE HOUSE COMMITTEE ON WAYS AND MEANS
SUBCOMMITTEE ON OVERSIGHT
SUBJECT - THE CURRENT U.S. INTERNATIONAL TAX REGIME

BODY:

Introduction
My name is Denise Strain, and I am the General Tax Counsel for Citicorp, a wholly owned subsidiary of Citigroup. Citigroup, the product of last year's merger of Citicorp and the Travelers Group, is a diversified financial services holding company whose businesses provide a broad range of financial services to consumers and corporate customers around the world.
On behalf of Citigroup, I want to thank the Chairman and the subcommittee for their invitation to testify today on the topic of international tax simplification. I also want to express my appreciation, and the appreciation of Citigroup, to Chairman Houghton, Chairman Archer, Congressman Levin, and other members of the House Ways and Means Committee for your efforts in this area. Over the last several years, the Houghton-Levin legislation has provided a road map for Congress in seeking to simplify and rationalize the U.S. tax rules that apply to the global operations of U.S.-based multinational companies.
Citigroup understands first hand that as the global economy has become increasingly more integrated, financial transactions have become more complex, financial decisions are being made more quickly, and the tax implications both here in the United States and in foreign jurisdictions have become more difficult to resolve. It is not an easy task to structure a tax system that addresses this evolving world of financial globalization in a manner that is fair and neutral while maintaining the competitiveness of U.S. business. The simple fact that you are conducting this hearing today sends a strong signal that we are making progress. The legislation introduced earlier this month by Chairman Houghton and Congressman Levin, which is aimed at further simplifying key aspects of the U.S. international tax rules, includes a number of important proposals. If enacted, these proposals will go a long way towards achieving a simpler and fairer tax regime for U.S. companies operating overseas.
Mr. Chairman, in my testimony today, I would like to discuss why we believe the goal of maintaining a tax system that keeps pace with global competition and economic integration is important. Specifically, I will discuss a number of provisions in H.R. 2018, the International Tax Simplification for American Competitiveness Act of 1999, that are of significance to the financial services industry, including Citigroup.
The Importance of International Tax Rules to Citigroup
To understand why U.S. international tax rules are so important to Citigroup, I think it will be helpful to the Committee if I explain a little bit about my company. As I mentioned in my introduction, Citigroup is a diverse company. We offer our customers a broad range of financial services, including banking, insurance, credit cards, asset management, securities brokerage, and investment banking. The principal subsidiaries of Citigroup include Citibank, Travelers Insurance, Salomon Smith Barney, and Commercial Credit. Citigroup has 170,900 employees located in 100 countries, including 111,640 employees in the United States.
Historically, U.S. financial services companies expanded abroad to support the global expansion of U.S. commercial businesses. As companies such as Caterpillar, General Motors, Exxon, and IBM have become global powerhouses and household names outside the United States, Citicorp and Citigroup have been there to provide capital for their expansions, and to provide banking and other investment services and advice to their employees. This is still the case as a new generation of American companies, including Microsoft, Intel, and Hewlett-Packard, have launched and expanded their foreign operations.
Unfortunately, U.S.-based multinational financial services companies could soon become an endangered species. Most of the world's large financial services players are foreign-based companies. Only three U.S.-based companies - Citigroup, BankAmerica, and Chase - are among the top 25 financial services companies in the world, as measured by asset size. Citigroup's foreign-based competitors are competing with us not only on foreign soil, but also on U.S. soil. These include such companies as Deutsche Bank, which recently completed its acquisition of Bankers Trust, and HSBC Holding, which is in the process of acquiring Republic Bank. Our foreign-based competitors in insurance are also increasingly making inroads into U.S. markets. For example, just recently, German-based Allianz AG acquired Fireman's Fund Insurance and the acquisition of Transamerica Corp. by Dutch-based insurance company Aegon NV is currently pending.
It is no coincidence that, for the most part, the home-country tax systems of these companies are simpler and more neutral when it comes to taxing home-country and international investment than the U.S. system, according to a National Foreign Trade Council (NFTC) study of foreign tax regimes and subpart F released earlier this year.
This level of increased competition from non-U.S.-based financial services entities results from the fact that national economies are becoming increasingly global. Globalization is being fueled by rapid technological changes and a worldwide reduction in tax and regulatory barriers to the free international flow of goods and capital. These changes are all for the good. However, these changes are also putting tremendous pressure on our tax rules, which have become increasingly antiquated over the last 30 years.
We can not afford a tax system that fails to keep pace with fundamental changes in the global economy, or that creates barriers that place U.S. financial services companies, as well as other U.S.- based multinationals, at a competitive disadvantage. Some have questioned whether the globalization of U.S.-based companies does much for U.S. economic growth and employment. In my company, the answer is easy. As Citigroup has grown internationally, our domestic support for those international activities has grown accordingly. For example, Citibank's U.S.-based credit card manufacturing and processing facilities produce credit card statements, inserts, and actual credit cards for Citibank customers in Europe, Latin America, and the Caribbean. Other Citigroup service centers in the United States process all the bills and payments for outside vendors the corporation utilizes around the globe, along with employee expense reports and reimbursements. We've found that consolidating many of these back- office functions in the United States achieves a maximum level of efficiency, just as the centralization of credit card manufacturing and processing takes advantage of economies of scale and R&E performed in this country.
U.S. trade policy has clearly recognized that breaking down barriers to international trade is a key factor in spurring U.S. economic growth and jobs, and this committee has played a leading role in that regard. It is ironic, therefore, that our international tax policy at times seems to go in a different direction. For example, we continue to face double taxation because our foreign tax credit rules are antiquated.

In addition, the question still remains among some whether the active income of financial services companies should continue to be subject to the anti-deferral regime of subpart F. These two factors -- the incidence of double taxation and the premature imposition of U.S. tax on our foreign earnings -- together hinder our ability to compete against foreign-based companies that face less hostile home-country tax regimes, according to the NFTC international tax study.
The Complexities in Our System
Moreover, our international tax regime imposes layer upon layer of needless complexity, creating an environment where taxpayers and the IRS are in a constant tug-of-war over rules that were not designed to apply in the context of many modern cross-border financial transactions.
From the standpoint of one of the largest financial services companies in the world based in the United States, we see the evidence of this first hand, every day. The labyrinth of rules and regulations we face are almost beyond comprehension. More often than not, applying these rules to increasingly complex transactions produces more questions than answers.
To give just one example of the complexities we face, at a time when American corporations are trying to concentrate on competitiveness and pare down nonessential costs, determining the earnings and profits of our foreign subsidiaries for subpart F purposes requires our staff to go through a five-step procedure. This process starts with the local books of account and then continues with a series of complicated accounting and tax adjustments. On audit, each of these steps must be explained and justified to IRS agents. Yet, equally reliable figures could be provided, at a fraction of the time and cost, by simply using GAAP to determine earnings and profits. I am glad to say that H.R. 2018 includes just such a rule, and we would recommend that this GAAP provision be extended to apply to calculations of earnings and profits of all foreign corporations for all purposes.
More generally, one of the biggest problems we face involves the coordination of U.S. rules with those of the countries in which we do business. It is a fact of life for Citigroup that our U.S. tax filing deadlines and requirements generally bear no relationship to those of other countries. This means that we generally do not have all the foreign information we need when our U.S. tax return is due, so our return contains tentative information, and we are forced to adjust our returns during the IRS audit process.
Mr. Chairman, I ask you to think about this: when you and I and tens of millions of other Americans finish our individual tax returns by April 15th every year, we breathe a long sigh of relief that an annoying, stressful, and time consuming process has been completed - until next year. For Citigroup, however, this task of filing our annual tax return is an ongoing process that often takes years to complete. This situation is ameliorated somewhat by a network of bilateral tax treaties intended to limit double taxation and coordinate information and other requirements between two countries' tax regimes. However, this network does not extend to many countries in which Citigroup does business, including such emerging market countries as Brazil and Argentina.
To give you some idea of the scope of the compliance burden for Citigroup, let me describe our tax filings. In September, Citigroup will file its 1998 tax return. It will exceed 30,000 pages in length, including computations for more than 2,000 companies located in 50 states and 100 countries. More than 200 tax professionals, both here and overseas, will be involved in this process. The end of this process is the examination of this return by IRS auditors, generally years from now. To say the least, it's a formidable process.
Tax Simplification Proposals
Mr. Chairman, we do believe that enactment of a modest number of changes to the current system will go a long way to help simplify some rules that are unnecessarily complex and time consuming to deal with. Moreover, I believe these changes will help us be more competitive.
Active Financing Exception to Subpart F
The rules that permit the active business income of U.S. banks, securities firms, insurance companies, finance companies and other financial services firms to be subject to U.S. tax only when that income is distributed back to the United States, expire at the end of this year. The proposal to make permanent or, at the very least extend, the exception to the anti-deferral regime of subpart F for the active income of financial services companies is of crucial importance to the U.S. financial services industry and is one of the key provisions in your bill.
By way of background, when subpart F was first enacted in 1962, the basic intent was to require current U.S. taxation of foreign income of U.S. multinational corporations that was passive in nature. The 1962 law was careful not to subject active financial services business income to current taxation, through a series of detailed carve-outs. In particular, dividends, interest and certain gains derived in the active conduct of a banking, financing, or similar business, or derived by an insurance company on investments of unearned premiums or certain reserves received from unrelated persons, were specifically excluded from current taxation. In 1986, however, the provisions that were put in place to ensure that a controlled foreign corporation's active financial services business income would not be subject to current tax were repealed in response to concerns about the potential for taxpayers to route passive or mobile income through tax havens.
In 1997, the 1986 rules were revisited for several reasons. A key reason was the fact that many U.S. financial services companies found that the existing rules imposed a competitive barrier in comparison to home-country rules of many foreign-based financial services companies. Moreover, the logic of the subpart F regime made no sense, given that most other U.S. businesses were not subject to similar subpart F restrictions on their active trade or business income. The 1997 Tax Act created an exception to the subpart F rules for the active income of U.S.-based financial services companies, along with rules to address concerns that the provision would be available to shelter passive operations from U.S. tax. At the time, the exception was included for only one year primarily for revenue reasons, as you yourself pointed out, Mr. Chairman, in remarks in support of the provision made on the House floor.
The active financing income provision was reconsidered again in 1998, in the context of extending the provision for the 1999 tax year, and considerable changes were made in response to Congressional and Administration concerns.
Active financial services income is generally recognized as active trade or business income. Thus, if the current-law provision were permitted to expire at the end of this year, U.S. financial services companies would find themselves at a significant competitive disadvantage vis-'-vis major foreign competitors when operating outside the United States. In addition, because the U.S. active financing exception is currently temporary, it denies U.S. companies the certainty their foreign competitors have. The need for certainty in this area cannot be overstated. U.S. companies need to know the tax consequences of their business operations, which are generally evaluated on a multi-year basis.
Not only should the current rules be extended, but we hope very much that Congress will refrain from making another round of major changes to these rules. In order to comply with the deferral rules, over the last two years U.S. companies have implemented numerous system changes to accurately follow two significantly different versions of the active financing law. While some in government have indicated problems still exist, we all need to remember that many U.S. companies, including Citigroup, have yet to file their first U.S. tax returns incorporating the 1997 Tax Act rules in this area. It will be another 15 months before tax returns are filed incorporating the rules that were enacted last year to apply to the 1999 tax year. Further changes at this time would create excruciating complexity and compliance burdens with no commensurate benefits for the U.S. Treasury.
Despite any real evidence that the current rules are not working, I understand that the Treasury Department has suggested that Congress hold off extending the active financing exception until Congress has had the time to review the Treasury's suggestions. However, the international growth of American finance and credit companies, banks, securities firms, and insurance companies would be impaired by an "on- again, off-again" system of annual extensions that does not allow for certainty. Failing to extend the active financing exception this year would be the antithesis of tax simplification. In contrast, making this provision a permanent part of the law, or at least extending the provision, would greatly simplify U.S. international tax rules and enhance the global position of the U.S. financial services industry.

The 10/50 Foreign Tax Credit Basket
As a regulated industry in many countries, U.S.-based financial services companies operating outside the United States are often required by local laws to operate in joint ventures with local banks and other financial services companies. That is why it is so important for my industry that the tax rules be simplified for income from foreign joint ventures and other business operations in which U.S. companies own at least 10 percent but not more than 50 percent of the stock in the foreign company.
In particular, the so-called 10/50 foreign tax credit rules impose a separate foreign tax credit limitation for each corporate joint venture in which a U.S. company owns at least 10 percent but not more than 50 percent of the stock of the foreign entity. The 10/50 regime is bad tax policy. The current rules increase the cost of doing business for U.S. companies operating abroad by singling out income earned through a specific type of corporate business form for separate foreign tax credit "basket" treatment. Moreover, the current rules impose an unreasonable level of complexity, especially for companies with many foreign corporate joint ventures.
The 1997 Tax Relief Act sought to correct these problems by eliminating separate foreign tax credit baskets for 10/50 companies. However, this important change will not take effect until after 2002, and it is accomplished in a rather complicated manner. Under the new rules, dividends from earnings accumulated after 2002 will get so- called look-through treatment, effectively repealing the 10/50 rules, while dividends from pre-2003 earnings will all be part of a single "super" 10/50 foreign tax credit basket.
Your bill, Mr. Chairman, would fix this problem. The proposal, which is also included in President Clinton's FY 2000 budget, would accelerate from 2003 to 2000 the repeal of the separate foreign tax credit basket for such "10/50 companies." In doing so, so-called look- through treatment would apply in order to categorize income from all such ventures according to the type of earnings from which the dividends are paid. The proposal would apply the look-through rules to all dividends received in tax years after 1999, regardless of when the earnings constituting the makeup of the dividend were accumulated. We very much support this approach and hope it can be enacted this year. In particular, the requirement of current law that we use two sets of rules on dividends beginning with the year 2003 has been a concern of taxpayers, members of Congress, and the Administration. That is why it is so important that the effective date of the 1997 Tax Act changes be accelerated and that the "super" 10/50 basket be repealed.
Application of the U.S. Aviation Ticket Tax to Foreign Frequent-Flyer Programs
Significant administrative and compliance problems have arisen due to the interpretation that the aviation ticket tax rules as modified in 1997 may apply to certain frequent-flyer "affinity" programs that operate outside the United States but involve carriers with flights to the United States. Your bill contains a modest change to the statute, giving the IRS and Treasury authority to address this issue in regulations that would adequately address this problem at very little cost to the Treasury.
This is important to my industry, Mr. Chairman, because credit card companies are among the largest providers of such affinity programs. Citibank and Diners Club, for example, compete throughout the world with locally-based banks and credit card companies. Under these affinity programs, these banks permit their customers to earn miles on air carriers when they make credit card purchases. We provide these miles to our customers by purchasing the mileage award points from the carriers.
Specifically, the problem relates to the extension of the 7.5 percent ticket tax to these purchases from air carriers of frequent-flyer miles by credit card companies, hotels, telephone companies and other consumer businesses for the benefit of their customers. The statute has been interpreted to apply this tax to the purchase of all mileage awards on a worldwide basis, including miles that could be redeemed for transportation that has no relationship to the United States. This interpretation has led to numerous diplomatic protests and has created competitive and administrative issues for the U.S. travel and tourism industry.
We also understand that the only parties actually paying the tax at this time are U.S.-based taxpayers, including U.S. purchasers of mileage awards and U.S.-based carriers. Because foreign-based carriers and purchasers of miles apparently take the position that the tax should not apply to transactions outside our borders, they are not paying the tax. This pattern of compliance is creating an unfair playing field for U.S. companies doing business in foreign markets.
The application of the aviation ticket tax to these foreign programs is a prime example of the need for simplification and rationalization in our tax rules. A simple solution to this problem would be to provide the IRS and Treasury with regulatory authority to exclude payments for mileage awards from the tax as long as the awards relate to individuals with non-U.S. addresses.
Withholding Tax Exemption for Certain Mutual Fund Distributions
We very much support the proposal included in the Houghton/Levin bill to exempt from U.S. withholding tax all distributions of interest and short-term capital gains to foreign investors by a U.S. mutual fund, including equity, balanced, and bond funds. Under the proposal, mutual fund distributions would be exempt from U.S. withholding tax if they were received by a foreign investor either directly or through a foreign fund. Similar legislation has been introduced in prior Congresses by Representatives Crane, Dunn, and McDermott.
Mr. Chairman, while the U.S. mutual fund industry is the global leader, foreign investment in U.S. funds is low. Today, less than one percent of all U.S. fund assets are held by non-U.S. investors. The current withholding tax that applies to all dividends distributed from a U.S. fund to foreign investors is a clear disincentive to foreign investment in U.S. funds. This is the case because distributions of interest income and short-term capital gains received directly, rather than from a fund investment, are not subject to withholding tax.
The proposed legislation would enhance the competitive position of U.S. fund managers and their U.S.-based workforce and simplify the administration of these funds.
Other Simplification Proposals
H.R. 2018 includes a number of other international simplification proposals that we would like to highlight.
Provide an Ordinary Course Exception to the Income Re-sourcing Rule for U.S.-Owned Foreign Securities Dealers
Current law provides that income received by a U.S. parent from its CFC will be re-sourced from foreign source to U.S. source to the extent the CFC is treated as having earned U.S. source income (for example, if the CFC derives interest income from a Eurobond). Recognizing that the existing rule is inequitable when applied to securities dealers, the bill would create an exception to the existing re-sourcing rule by providing that income earned by a securities dealer from securities held in the ordinary course of conducting its customer business will not be re-sourced.
Treat a Foreign Securities Firm's Market-Making Activities in its Parent Company's Issuances Consistently with its Market-Making Activities in Other U.S. Companies' Securities
U.S.-owned foreign securities firms, as part of their ordinary course market-making activities, will hold in inventory securities of U.S. corporations. Thus, for example, a foreign securities firm may hold in inventory a Eurobond issued by General Motors. However, Citigroup's foreign securities dealers are effectively prohibited from holding Citigroup issuances in inventory over quarter-end because the holding of that security would give rise to a subpart F deemed dividend. The bill would eliminate this rule for parent and affiliate securities held by a U.S.-owned foreign securities dealer in the ordinary course of its market making activity.
Conclusion
On behalf of Citigroup, we want to thank you, Mr. Chairman, and members of the Ways and Means Committee for your interest in international tax simplification and the impact of current rules on my company. As a representative of a U.S.-based financial services company with operations throughout the world, I believe your efforts to simplify and rationalize the U.S. international tax rules are vitally important. Thank you again for the opportunity to testify today.
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LOAD-DATE: June 23, 1999

Document 81 of 113.


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